Applied Rationality focuses on public policy issues and tries to take a liberal perspective that is consistent (comments to the posts will often show otherwise) with neoclassical, rational-choice economics.

Monday, July 20, 2009

Pros and cons of a "local currency"

A local group, the Greensboro Currency Project, is pushing a local currency. In an op-ed this weekend, Signe Waller Foxworth, a co-chair of the group touted the possible benefits of this idea.

Imagine everyone in Greensboro, particularly those chronically short of money, being able to meet many more of their basic needs.

Imagine a thriving community, with small and medium-sized local businesses supplying many goods and services to city residents and able to employ more workers. This attractive vision represents the real-life potential of a local currency in Greensboro.

The obvious John Lennon allusions are nice. Nicer still would be a cogent explanation of how a local currency might be implemented or how it might achieve the listed benefits.

Let's take a stab at those benefits. A local currency can take several forms, but a common feature is that it serves as a medium of exchange in a particular--usually geographically defined--market. Thus, it has some, but not all, of the features of regular currency.

Because it is only accepted within a defined market, a local currency promotes trade within but not outside that market. You could view the currency as a form of trade barrier. It promotes local goods over goods in the next community over. Local goods effectively become less expensive, leading to greater purchases by local residents. At the same time other communities' goods become relatively more expensive, leading to less external trade. If local currencies are adopted by a few communities, those communities might enjoy positive effects, but they are adopted by all or many communities, they could actually reduce economic activity by hindering trade.

A local currency may stimulate the economy in other ways. Opportunities for financial intermediation are likely to be limited or absent. Because of this, there would be few rewards for using the currency to save or invest. Instead, people would get their primary reward from spending the currency. This would give local currency purchases a bigger multiplier than regular currency purchases. This effect, however, would be offset to the extent that people substitute use of the local currency for local shopping and use of the national currency for other transactions.

Another stimulative effect could come from simply boosting the amount of available currency--that is, increasing the money supply. Increasing the supply too fast, however, will end up devaluing the currency.

Some additional positive effects of the currency are to promote awareness of local producers and merchants and to increase social cohesion.

Unfortunately, as the foregoing discussion suggests there are a number of drawbacks. First, a local currency does not help--and may hinder--trade outside the region. Greensboro boasts a number of "exportable" industries, including logistics and financial services. Second, the goodwill that may be produced locally may be offset by ill will from surrounding communities. The currency sends a message to other communities that our businesses are important while theirs are not. Third, there are overhead costs because new institutions will have to be created to implement and manage the currency. Fourth, there will be inefficiencies from having to exchange currencies to trade externally (electric bills and merchants' payments to suppliers are examples) or make external payments (sales tax bills).

Fifth, there is the whopping question of how the currency is put into circulation in the first place. A local group could "sell" the currency, but this would reduce the stimulative impact by taking regular currency out of circulation. Alternatively, if the currency is distributed it represents a windfall to whomever gets it or uses it first. How will that windfall be distributed?

Finally, do we expect that the currency will circulate forever? If not, how do you address the problems faced by the last people stuck holding the currency? One solution to sell the currency and then maintain reserves of the regular currency to back it up. Again, however, taking regular currency out of circulation defeats some of the purposes of the local currency. Also, maintaining the necessary reserves is a tremendous responsibility.

In their quest for something exotic, the backers of a local currency seem to have overlooked simple alternatives that are used in numerous cities--local merchants' cards and coupon books. The cards or books can be sold, with the proceeds going to local development or advertising/promotion campaigns, or they could be given away. The discounts (price reductions) would encourage shopping. The discounts could also be time limited, giving them a use-it-or-lost-it quality.

It's fun to imagine ways to play games with "monopoly money," it's more practical work to with things that work.